Sometimes it helps to break apart a business into 2 businesses to get an accurate view of growth, particularly if you are looking ahead more than 1 year. For example, at the beginning of year 1, a company has 2/3 of its revenue growing at 60% and 1/3 of its revenue growing at 30%:
$667 grows to $1067
$333 grows to $433
Total growth was $500 or 50%.
But to take assume a 50% blended rate and project that forward would be an underestimate of future growth. Look what happens in years 2 and beyond.
$1067 x 1.6 = $1708 or a gain of $641.
$433 x 1.3 = $563 or a gain of $130.
The total gain of $771 on $1500 was growth of 51.4%, not 50%
In year 3, we get the following:
$1708 x 1.6 = $2732 or a gain of $1016.
$563 x 1.6 = $732 or a gain of $169.
The total gain was $1185 on 52.2% (note that it is departing father from the initial 50% “blended rate”.
Each year, the faster growing component becomes more and more relevant and a bigger and bigger contributor to the growth.
We have several companies in this situation.
Twilio has 2 components growing at different rates, on larger one at 60+% and one smaller one at half that rate. To blend them from last year’s result will result in an underestimate of future growth. So long as the component growth rates don’t change, this difference will become increasingly pronounced. (Ron, be careful when blending rates if you want to project years into the future).
Square is more complex. It has a fast growing, high margin, recurring revenue subscription business growing at 97%. It also has a slower growing, lower, margin transaction based business. The fast growing business is 45% of SQ and at about 71% gross margin. The transaction based business is only growing at 29% and has only 37% margin. Now, the “hardware business” has not be discussed here yet. It was $72M in 2018 and grew at 55%. However, it is not really a business…more of a marketing expense as it provides zero gross margin. The hardware was a slight drag on the blended growth rate because it was below 59%.
The main point is that a fast growing component of growth is better than having the whole business growing at the same rate. The bigger the fastest growth component, the better. The higher margin of the fast growing component, the better. SQ has both of these going for it. TWLO has the slower growing part with high margin so the reverse would be better. Let’s hope TWLO can do lots of cross selling in the next few quarters!